T2S opens many doors in the world of collateral and liquidity. At its simplest, financial intermediaries will soon be able to open up one account for settlement purposes and one for related cash settlement in place of one account in every market where they currently trade securities. This one dedicated account ought to consolidate settlement activity and reduce the amount of cash that traders are required to keep at Central Banks. It will also free up resources for investment in other areas. At a more complex level, T2S will dramatically expand the collateral available across the European and global marketplaces by consolidating settlement and merging collateral channels. This will be most profound in the use of equities as collateral.
T2S is designed to settle a variety of securities including fixed income and equities. Adding 22 Central Securities Depositories (CSDs) means that a large new pool of equities will be introduced onto the platform. In addition, individual CSDs are working to establish direct links with one another. In a very short period, the resources of the T2S market will find their way into the global collateral marketplace.
As the European Central Bank noted in a T2S update:
Collateral in Europe is today divided up into multiple pools. Collateral givers and collateral takers may not necessarily hold their securities accounts in the same settlement system. One can picture several goldfish living in different bowls; each goldfish may be able to see which of the other bowls holds the best food or companionship, but it is not easy to get there…. T2S was conceived before the crisis. However, the need to mobilise collateral rapidly and safely, as a result of the crisis, has made it all the more necessary.
The goldfish analogy can be extended easily to equities, where T2S not only aggregates diverse markets but also bestows a new legitimacy on equities as collateral. Individual securities markets operating in isolation do not make for good collateral holdings. Market participants may be concerned about the ability to easily sell and settle securities in the event of default, and transactions may need to occur in far-away locales with uncertain settlement practices. T2S changes this by harmonizing equity settlement on one platform, thereby providing a certainty that settlement will occur on T+2 for all securities involved.
The Legitimacy of Equities
Rightly or wrongly, the European Central Bank’s association with equities will also mean that market participants may be more willing to accept equities as collateral. Settlement will be guaranteed by the ECB in Central Bank money, bringing a new level of quality to these assets. Equities may have haircuts and may be Level 2B High Quality Liquid Assets under Basel III, but the accessibility of equities under the T2S system will mobilize an entirely new swath of collateral to global market participants.
Central Securities Depositories operating tri-party platforms such as Clearstream are well aware of the possibilities of expanding collateral pools to include more equities. As part of The Liquidity Alliance of CSDs globally, Clearstream announced in November 2014 that it would extend T2S access to all Liquidity Alliance members. According to the press release, “The Liquidity Alliance is planning to extend the offering to include offshore assets for the coverage of domestic exposures as well as to mobilise domestic assets for the coverage of offshore exposures.” The extension of T2S to the international market is an important concept, as this forms a major pool of collateral liquidity that can be accessed via any Liquidity Alliance member through Spain’s Iberclear or Clearstream’s domestic CSD in Germany.
It would also come as no surprise for Clearstream to integrate the tri-party activities of its international CSD with its German CSD, thereby extending the available collateral pool even further. Clearstream Banking Frankfurt, the German CSD, will be the point of access to T2S. The ICSD, Clearstream Banking S.A., will be the global tri-party manager with access to The Liquidity Alliance. These pools of liquidity will be combined for global collateral mobilization.
As concerns about the scarcity of collateral come and go, the inclusion of equities across the T2S markets means that equities will be mobilized as never before for collateral purposes. The ECB’s role as settlement agent for participating markets means that core assumptions about equities as collateral will change for market participants. This will happen not just in Europe but worldwide.
This article was commissioned by Clearstream.